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UESTION 1 (17.5 MARKS) A mortgage company deals in mortgages has been able to raise $10 million by issuing a Eurobond at a fixed interest rate of 6%p.a. over three years, payable annually, for the purpose of providing mortgages on a floating rate basis (with interest rates reassessed annually). It is exposed to the risk that interest rates might fall with the effect that interest receipts from the mortgages are inadequate to meet the interest payments on the Eurobond. The mortgage company decides to reduce its exposure by swapping its fixed-rate liability one on a floating rate basis. It finds a bank prepared to enter a floating for fixed swap on the basis of receiving LIBOR +0.70% p.a. in exchange for paying 6% p.a. Initially LIBOR stands at 5.30% p.a. LIBOR rises by 0.5% between the first and second years, while between years 2 and 3 LIBOR falls by 1.5% Required: Based on the information provided, i complete the table below Year Cash flow from mortgage Floating interest payments Fixed rate interest payments company to bank 1 2 3 Explain with appropriate calculations, whether the swap agreement was beneficial to the [8 Marks] mortgage bank b) A US Multinational Company wants to finance a 65,000,000 expansion project of an Italian plant which is relatively new. The company has a number of options. They could borrow US dollars and convert it to euros to finance the project, but they may be exposed to exchange rate risk. They could also borrow in Italy but could suffer high interest rate in Italy since the company is relatively new. They therefore decide to use the third option of finding a counterparty to set up a currency swap. Fortunately, for the company they find a counter party who is willing to enter into a currency swap to exchange the equivalence of 65,000,000 dollars. Currently, the spot exchange rate, is $/ =1.2. Their borrowing opportunities are given as follows: U.S MNC (Say company A) French company (Company B) $ 8.0% 9.0% 7.0% 6.0%